Trading Underlying Assets vs Trading Price Action: What are the Differences?

The world of trading is rife with different strategies, each aimed at getting the best out of the market at any one point. Ultimately, though, the strategy applied is one the investor understands, including its risks, benefits, and influence on a portfolio.

In this read, we’ll be focusing on two types of trading strategies: underlying assets and price action. They have been selected for their popularity among crypto enthusiasts and traders, especially as they allow for trading derivatives crypto and primary assets while monitoring market performance. That said, let’s get into it.

Underlying Assets: What are they?

Underlying assets are real financial securities or assets that impact the value of another financial derivative. That is, another asset class is based on the availability of an underlying asset. Derivatives are securities or instruments created from other financial securities or assets.

With such a close bond between underlying assets and derivatives, it can be challenging to tell them apart, especially for fresh-faced investors. To mitigate this risk, both securities are traded on different markets. Underlying assets almost always appear on spot or cash markets, while their resulting derivatives are available on specialized exchanges, like over-the-counter markets, private exchanges, and futures trading exchanges.

Underlying assets trading holds in spot markets, especially when there are financial assets involved because the process of acquiring the asset requires a full upfront period. Variations to this rule exist, though, with some markets allowing for a 1 to 2-day period. Derivatives of this asset class typically operate under different rules, and may not demand a complete upfront payment to obtain them. Thus, there is a scintilla of leverage derivative trading brings to the table.

The bulk of the stocks listed and traded on many exchanges are underlying assets linked to the many options and futures derived from them.

Price Action: What is it?

Price action trading involves studying price changes in the market. Several tools used in technical and fundamental analysis are influenced by market price—things price action avoids by studying the price itself. Price Action tracers believe that price trends hold all the key information about the market required to make a successful trade.

It’s this ideology that sets this trading strategy apart from others, which rely on mathematical indicators to make a move. The two crucial factors to bear in mind during price action trading are time variables and price as found on a clean chart. A clean chart simply shows the price and time variables in the market without any other indicator to influence traders.

Indicators like Bollinger bands and moving averages seldom make it into the strategies of most price action traders. Even the ones who consider them take them with a pinch of salt when making decisions. The only element these traders believe and take seriously is the price itself and its corresponding movements during a trading day.

So, when the price of securities grows, it’s an indication of more buyers than sellers and vice versa. Price action traders analyze the price action ongoing in the market based on the momentum of buying or selling, including historical charts and real-time price movements from magnitude, volume, bids, velocity, and offers.

Differences between Trading Underlying Assets and Price Action Trading

This section discusses the disparities between both trading strategies to help investors decide which works best for them and what to expect:

Priorities

The priorities of trading price action and underlying assets couldn’t be further apart. In the former, price is the most important factor in deciding whether to partake in a trade or market session. Whereas, for underlying assets, the priority is the primary security that influences value.

Decision-making

As a day trading strategy, price action traders depend on price movements in the market in real time to decide on whether to join a trade. Underlying asset traders, on the other hand, consider the performance of the primary asset over time to make decisions.

Research Intensive

There is a lot going on with underlying assets trading. Traders must understand the primary security the derivative is based on, including the risks and historical precedents set over time. This culminates in an intensive research process before one can make a decision. However, in price action trading, traders can simply follow patterns for a few minutes to decide on the action to take. It’s simply a question of whether to buy or not to buy. And since there is no mathematical analytics involved, the process isn’t nearly as research intensive as underlying assets trading. However, it does require your complete focus and effort.

Speculative Trading

When trading in spot markets for futures or options, price action aims to speculate price and profit from reflections in the market. As such, it’s a great tool for making quick, strategic market decisions. On the other hand, underlying assets trading may be more susceptible to the adverse effects of speculative trading in the derivatives market. For instance, the prices of real estate were sky-high during the 2007 housing crisis. Speculative trading was partly responsible for the hullabaloo, as many traders invested in overly sophisticated derivatives contracts and mortgage-backed securities. When the derivative bubble popped, it came as no surprise that the value of underlying assets plummeted.